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The International Journal of Accounting 50 (2015) 31 52

Institutional Investors, Risk/Performance

and Corporate Governance
Marion Hutchinsona,, Michael Seamerb , Larelle (Ellie) Chapplea
a

Queensland University of Technology, Australia

b
University of Newcastle, Australia
Received 17 September 2013
Available online 9 January 2015

Abstract
Modern portfolio theory suggests that investors minimize risk for a given level of expected return
by carefully choosing the proportions of various assets. This study sets out to determine the role of
the institutional investor in monitoring risk and rm performance. Using a sample of Australian rms
from 2006 to 2008, our empirical study shows a positive association between rm-specic risk, riskmanagement policy, and performance for rms with increasing institutional shareholdings. The study
also nds that the signicance of this association depends on the institutional investor's ability to
inuence management, which in turn depends on the size of ownership and whether the investee rm
does not have potential business dealings with the investor. We also nd that when rms are
nancially distressed, institutional investors engage in promoting short-term performance or exit
rather than support long-term value creation. The results are robust while controlling the potential for
endogeneity and using sensitivity tests to control for variants of performance and risk. These ndings
add to the growing body of literature examining institutional ownership and the importance of
understanding the role of risk-management in the risk and return relation.
Crown Copyright 2014 University of Illinois. All rights reserved.
JEL classification: M40; G34
Keywords: Institutional investors; Corporate governance; Risk and performance

1. Introduction
Many researchers and practitioners have identified excessive risk-taking as the major
contributor to the global financial crisis (GFC) and highlight the importance of institutional

Corresponding author.

http://dx.doi.org/10.1016/j.intacc.2014.12.004
0020-7063/Crown Copyright 2014 University of Illinois. All rights reserved.

32

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

investors in this scenario (Callen & Fang, 2013; Gorter & Bikker, 2013). The GFC highlights
the importance of an appropriate corporate governance structure for managing risk. The
purpose of this study is to determine the role of institutional investors in the riskreturn
relation in a period of increasing risk-taking, the GFC. The question is whether institutional
investors actively engage or seek out information on the risk-management practices of their
portfolios or whether they pursue aggressive risk-taking and favor short-term profits.
This question is particularly important in a country such as Australia, where employers in
all sectors are required to contribute to a compulsory employee superannuation scheme.1 This
means that Australia has the fourth-largest pension fund pool in the world, creating enormous
investment opportunities.2 In addition, the global financial crisis provides a unique setting to
determine the consequences of institutional investors' involvement in, and influence over,
corporate management and board behavior in the period leading up to the crisis. The OECD
countries that experienced the fastest economic growth in the 15 years prior to the global
financial crisis including the US, the UK, Australia, and Ireland were also the countries
with the greater financial sector deregulation (Pomfret, 2009). However, financial
deregulation increases vulnerability to a financial crisis (Pomfret, 2009). When the global
financial crisis unfolded, it was regarded as unexpectedly sudden (Sidhu & Tan, 2011).
Although it is generally accepted that the Australian market suffered less of an
economic downturn than other economies (Reserve Bank of Australia, RBA, 2010), the
downturn increased business risk through, inter alia, its impact on equity and credit
markets (Xu, Jiang, Fargher, & Carson, 2011). While we can evaluate the impact of the
global financial crisis in hindsight, there was a climate of uncertainty in the investment
community from the global effects, and it is in this environment of escalating uncertainty
that we examine the risk-return relationship.
In our study, we model firm performance as a function of firm-specific risk, riskmanagement practices and the size of institutional ownership. While controlling for potential
endogeneity, we determine whether the size of institutional investor has any influence over
the association between risk and performance, measured as return on assets. The results of
the 3SLS regression show that increasing levels of firm-specific risk and a comprehensive
risk-management policy is associated with increasing institutional ownership and firm
performance. Further investigation reveals that this association is only significant for
pressure-resistant institutional investors. Research defines pressure-resistant investors as
those who do not have the scope for economic bonds and who are less averse to challenging
management. Pressure-sensitive institutional investors have the potential for business
relations with investee firms and are therefore less likely to challenge management for fear of
losing business (Brickley, Lease, & Smith, 1988).
This study contributes to the literature relating to the influence of institutional investors
on the relationship between risk and firm performance in several ways. First, our results
demonstrate that firm-specific risk and risk-management practices are an important
determinant of the size of institutional investment. Our study helps to explain previous
conflicting results on whether institutional investors consider the governance practices of
1
Employers are required by law to pay an additional amount based on a proportion of an employee's salaries
and wages (currently 9.25%) into a complying superannuation fund.
2
http://www.asx.com.au/documents/research/nancial_sector_factsheet.pdf.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

33

the firms in which they invest. This information can enable diversified investors to
structure their portfolios in accordance with their risk preference. Second, we contribute to
the question on whether large institutional investors are active in ways that improve firm
performance by investigating whether institutional investors monitor the risk and
performance relationship. Third, further analysis reveals that institutional investors exit
financially-distressed firms in the long term.
The results of this study are important because they shed some light on the influence of
institutional investors in periods of increasing risk. Since the global financial crisis, researchers
have called for more research into this area. Bebchuk and Weisbach (2010: 6) wrote:
The financial crisis has intensified the ongoing debate about the role that
shareholders should play in corporate governance. To some, increasing shareholder
power and facilitating shareholder intervention when necessary is part of the
necessary reforms. To others, activism by shareholders who potentially have shortterm interests is part of the problem, not a solution. To what extent (and when) can
shareholder activism improve firm value and performance? To what extent (and
when) can shareholder activism produce distortions that make matters worse?
Research by financial economists that seeks further light on these questions will
provide valuable input to the questions with which decision-makers are wrestling.
2. Background and hypothesis development
The traditional capital asset pricing model (CAPM) suggests that there is no economic gain
to diversified investors from reducing firm-specific risk, because they will not receive a higher
risk premium on the asset. Only non-diversifiable (systematic or market) risk (beta) is rewarded.
A sufficiently diversified portfolio limits the risk exposure to systematic risk only, and the level
of systematic risk is not affected by the failure of any one firm. Therefore, excessive managerial
risk-taking is not considered problematic to a diversified shareholder because one firm's failure
will not affect a diversified investor's portfolio in any directional way.
Gordon (2010: 4) explains diversified investor attitude to risk: Competitors of the failed
firm may do better; suppliers to the failed firm may do worse, but the consequences are
unbiased. If all firms are taking good bets, however, then on average the diversified investor
will be better off. Consequently, shareholders are risk neutral. Institutional investors can
invest in different equities to diversify risk and maintain liquidity. We expect a positive
association between the size of institutional ownership and firm risk, because research tells
us that shareholders prefer more risk (Jensen & Meckling, 1976; Pathan, 2009) due to the
anticipated higher return for greater risk. Subsequently, firms are likely to take on more highrisk projects to attract greater institutional investment. This leads to our first hypothesis:
H1. The level of firm risk is positively associated with institutional ownership.
2.1. The role of institutional investors and risk-management
In contrast to the CAPM's assumption of a trade-off of higher risk for higher return,
modern portfolio theory suggests that investors minimize risk for a given level of expected

34

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

return by carefully choosing the proportions of various assets. While more investment risk
typically results in higher expected returns, it can also lead to a mismatch between portfolio
assets and liabilities, thereby eroding beneficiaries' future returns as demonstrated by the
recent global financial crises.
Modern portfolio theory suggests that even large institutional investors might want to
reduce firm-specific risk because large investors internalize, at least partially, the
consequences of firm failure (systemic risk) and are wary of excessive risk-taking
(Gordon & Muller, 2011). These firm-specific risks include such things as the risk created
by poor risk-management practices. Consequently, institutional investors are more likely to
invest in firms with governance practices that concur with their fiduciary duties (Hawley &
Williams, 2000) and reduce their costs of monitoring (Bushee & Noe, 2000).
Institutional investors with a large investment in a firm have a direct incentive to seek
more comprehensive information on the risk-management practices of their portfolio firms
and to respond through exit or engagement (Harper Ho, 2010). These large institutional
investors influence the firm directly through ownership in the investee firm or indirectly by
trading their shares in the firm (Gillan & Starks, 2003). Heavy selling by these investors can
cause the share price to decline, or can be interpreted as bad news, thereby triggering sales by
other investors, further contributing to a decline in share price (Baysinger, Kosnik, & Turk,
1991; Parrino, Sias, & Starks, 2003) and an ensuing increase in the cost of capital.
While some research finds that institutional investors reduce agency costs (e.g., Gillan &
Starks, 2000, 2007), others argue that they can also create agency costs (Stapledon, 1996;
Webb, Beck, & McKinnon, 2003). They suggest that there are several disincentives for
institutional investors to actively participate in the governance of portfolio firms. Webb et al.
(2003) refer to: high transaction costs; the use of index-tracking funds; the inability of
investors to influence company strategy; and, the free-ride of other investors on the
acquisition cost of the institutional investor.
Agency theory suggests that the divergent risk preferences of risk-neutral (diversified)
shareholders and risk-averse managers necessitate monitoring by the board (Jensen &
Meckling, 1976; Subramaniam, McManus, & Zhang, 2009). Consequently, without
monitoring, risk-averse managers may reject profitable (risky) projects that are attractive to
diversified investors. The challenge for diversified investors is to encourage managers to
take all positive net present value investment opportunities despite the likelihood that some
risky projects will turn out badly, thus increasing the probability of bankruptcy.
Despite the assertion by some researchers that diversified investors are not concerned
with corporate governance of individual firms (Callen & Fang, 2013), we suggest that how
firms manage risk is important to all types of investors, particularly those with substantial
skin in the game. Firms design their governance practices to monitor managerial
behavior and to curb suboptimal risk-taking. Recent research shows that suboptimal risktaking is reduced by corporate governance, as firm-specific risk is negatively associated
with the governance variables of board independence and director qualifications (Christy,
Matolcsy, Wright, & Wyatt, 2013).3

Christy et al. (2013) use stock return volatility as their measure of risk when testing the association between
corporate governance variables and risk.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

35

Information regarding firm-level risk-management practices might increase the quantity

and quality of information available to the market and better enable institutional investors
to structure their portfolios in accordance with their risk preferences. Institutional investors
rely on the information reflected in market prices and on financial agents' responses to
those prices. If market efficiency is limited, the market may only imperfectly account for
risk. Incorporating risk-management factors into investment analysis may offer a way for
investors to achieve higher risk-adjusted returns.
Firms' risk-management includes monitoring the level of risk the firm is exposed to
while keeping in mind the desire to maximize returns. The firm may have a separate
committee (a risk-management committee) that advises the board on the firm's management of the current risk exposure and future risk strategy (Walker, 2009), thus shifting
the risk-monitoring costs from the institutional investor to the firm. Consequently, we
anticipate that, given institutional investors are diversified investors with a propensity to
invest in high-risk firms, they will increase their investment in firms with a comprehensive
risk-management policy. We expect a positive association between the size of institutional
ownership and comprehensive risk-management policy,4 whether due to institutional
investor pressure to improve risk-management or from efforts of portfolio firms in
improving risk-management practice to attract higher institutional investment.
H2. The comprehensiveness of firms' risk-management policy is positively associated
with the size of institutional ownership.
2.2. Risk, performance and institutional investors
Institutional investors (and portfolio managers) are under pressure to show short-term
returns, as they are rewarded and reviewed based on quarterly, or at most, annual
performance results (Aguilera, Rupp, Williams, & Ganapathi, 2007; Baysinger et al., 1991;
Graves, 1988). As such, these investors are predisposed to supporting investments when
there is an immediate association with profits, such as mergers and acquisitions, to maintain
short-term competitiveness rather than taking a long-term view in their investment decisions
(Graves, 1988).
This study empirically determines whether the level of institutional investment is
associated with a positive risk/performance relationship. Do institutional investors invest in
high-risk firms in anticipation of making short-term returns? Firm risk, as a measure of the
firm's information environment and the risk of its operating environment, is a potentially
important determinant of firm performance.
Bowman (1980) finds that the relationship between risk and return could be
negative when accounting measures are used as measures of return. Bowman (1980)
tested his hypothesis that prosperous firms will avoid high-risk investments, because
the consequences of failure will affect their reputation, while poorly-performing firms
will pursue risky investments in the hope that high returns will reverse their poor
performance. Bowman tested this hypothesis by examining firms' annual reports over

Comprehensive risk-management is evidenced by written policies with separate committee oversight.

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M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

a nine-year period for over 1500 companies in 85 different industries, and found that
higher returns (ROE) carried lower risk, and lower returns carried higher risk (Raynor,
Ahmed, & Shulz, 2010).
Raynor et al. (2010: 105) state that risk is prospectiveforward-looking and
unavoidably based on subjective assessments of the probability of future outcomeswhile
results (the returns to the investment) are retrospective and much more nearly in the realm
of facts. The objective of this study is not to prove or disprove Bowman's hypothesis,
only to report what we have observed from the data.
We posit that large institutional shareholders are more likely to influence the risk/
performance relation and are more likely to influence proxy voting if their demands are not
met (Johnson, Schnatterly, Johnson, & Chiu, 2010). Subsequently, we expect the size of
institutional investment to influence the association between risk and performance. The
more skin in the game institutional investors have, the greater the motivation to monitor
the risk/return of the investee firm. Recently, Callen and Fang (2013) find that institutional
ownership by public pension funds is significantly negatively associated with the risk of
future stock price crash. Based on the preceding discussion, the following hypothesis is
posited:
H3. A positive association between risk and performance depends on the size of
institutional investment.
3. Method
3.1. Sample selection
The sample period 20062008 is relevant, as the study looks at the association between
risk and performance in a period of escalating risk (the global financial crisis). The
corporate governance profile of the investee firms is examined from 2006, as this provides
a sufficient time lag to account for the Australian Securities Exchange Corporate
Governance Council best practice guidelines that were first introduced in 2004 (Australian
Security Exchange Corporate Governance Council, 2007). The global financial crisis
essentially impacted Australia by the end of January 2008, when the stock market dropped
17% with an ensuing bear market (Brown & Davis, 2008); accordingly, the sample period
ends in 2008.
The sample was constructed from the Top 400 firms in terms of market capitalization
listed on the ASX, which was reduced to 316, as each firm is required to be in the Top 400
for each year (20062008) and to lag variables into 2005. The sample was further reduced
due to the lack of institutional investor data for some companies. The final sample consists
of an unbalanced panel data set of 256 firms listed on the Australian Securities Exchange
for the years 2006 to 2008 (712 observations), based on the availability of the relevant data.
Ownership data is collected from the Osiris database, and archival data on firms' corporate
governance characteristics is hand collected from company annual reports. Financial
variables are provided by Aspect FinAnalysis. Risk measures are obtained from the Centre
for Research in Finance (CRIF) risk measurement service of the Australian School of
Business, University of New South Wales.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

37

3.2. Research model

In this study we use instrumental variables in the form of 3SLS regression models to
capture cross-equation effects, as error terms of individual equations in the system are
assumed to be contemporaneously correlated. Also, the 3SLS estimation technique is more
suitable for cross-sectional studies, where some of the institutional investors own multiple
equity stakes in different firms across industries with different levels of risk. As a result,
institutional ownership, risk, and performance issues can affect each other in various ways.
These interactions can be captured through the 3SLS estimation technique.
To eliminate the potential endogeneity problem or two-way causality, we endogenize
risk, risk-management, and performance (ROA and Tobin's Q). The three equations are
solved as a system of simultaneous equations using the three-stage least squares (3SLS)
estimation method. The effect of institutional ownership and risk-management policy on
firm-specific risk is specified by Eq. (1). The effect of firm-specific risk and institutional
ownership on risk-management is specified in Eq. (2). Finally, the effect of firm-specific
risk, risk-management, and institutional ownership on ROA is specified in Eq. (3). The
equations set out below are used to test H1, H2, and H3 simultaneously.
To test hypothesis 1, the endogenous variable is the industry-adjusted measure of
firm-specific risk, with instrumental variables of net gearing,5 net interest coverage,6 and
risk-management. The level of risk may be due to large institutional investors increasing
pressure on management to invest in risky projects, or it could be that institutional owners
invest in firms with high risk. We use the following equation in the model to test H1:
INDADJSTD 0 1 ALLINST 2 NETGEARING 3 NETINTCOV
3 RISKMGT :

Next, we test the impact of increasing institutional ownership on firms' riskmanagement practices by considering the interaction between the size of institutional
investment and firm-specific risk on the comprehensiveness of firms' risk-management
policy. The instrumental variable is firm size measured as the log of total assets. The
regression equation for H2 is:
RISKMGT 0 1 INDADJSTD 2 ALLINST 3 LNTA :

We test the impact of increasing institutional ownership on firms' performance by

considering the interaction between the size of institutional investment and risk-management
for a given level of firm-specific risk. When institutional investors own a large proportion of
the firm's shares and the firm has a comprehensive risk-management policy, we expect a
positive association between risk and performance. With high ownership concentration,
institutional investors have the incentive and ability to pressure management to monitor risk
5
6

(Short term debt + long term debt cash) / shareholder's equity.

Earnings before interest and tax / net interest (income expense).

38

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

and performance more closely. The instrumental variables are prior-year performance,
market capitalization, industry, and year. The model for testing H3 is:
PERFORMt 0 1 PERFORMt1 2 INDADJSTD 3 RISKMGT 4 ALLINST
5 LNMKTCAP 6 INDY 7 YEAR :
3
3.3. Endogenous variables
3.3.1. Firm performance
As there are various measures of firm performance used in prior research, this study
uses two measures of performance: accounting performance and firm value. Accounting
performance, the firm's return on assets (ROAt), is likely to be influenced by the firm's
managerial risk-taking behavior. ROAt is an indication of the ability of the firm to produce
accounting-based revenues in excess of actual expenses from a given portfolio of assets
measured as amortized historical costs (Carter, D'Souza, Simkins, & Simpson, 2010).
ROAt is measured as net income plus interest expense multiplied by (1-corporate tax rate)
and divided by total assets less outside equity interests at year end t.
As a measure of firm value, we use Tobin's Q. Tobin's Q is measured as the market
value of the firm divided by replacement value of assets. If Tobin's Q is greater than one,
the market value of shareholder and creditor investment is greater than the amortized
historical cost of the assets. Because Tobin's Q measures the market value of shareholder
and creditor investment, it encompasses a market assessment of the investment opportunity
set and future cash flows of the firm.
This study adopts a simple measure of Tobin's Q as adopted by Agrawal and Knoeber
(1996). The market value of the firm is the market value of equity (total number of issued
shares by the ordinary share price at year end) and debt (total of short and long-term debt).
The replacement value of the firm's assets is the book value of total assets. This simple
measure of Tobin's Q is adopted because it is highly correlated (0.93) with the traditionally
inflation-adjusted figures and for ease of computation. This measure is particularly
relevant, as Australian firms report the re-valued asset figures for property, plant, and
equipment.
3.3.2. Risk
Risk is measured by the standard deviation of the firm's daily stock returns for each
fiscal year (STDEV). It is measured as the standard deviation of the rate of return on equity
for the company, and is expressed as a rate of return per month computed from the
(continuously compounded) equity rates of return for the company's equity.7 The standard
deviation is a measure of historical volatility, and is used by investors to gauge the amount
of expected volatility. This measure encompasses both systematic and unsystematic risk
7

It is measured over the four-year period ending at the companies' annual balance date. All measurable monthly
returns in the four-year interval are included. Individual monthly returns measure total shareholder returns for the
company, including the effects of various capitalization changes such as bonus issues, renounceable and nonrenounceable issues, share splits, consolidations, and dividend distributions.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

39

(Carr, 1997), and has been used extensively. We control for industry risk by using i net of
industry risk (INDADJSTD), which results in a measure closer to firm-specific risk.

3.3.3. Risk management

Companies are classified into one of three groups depending on the comprehensiveness
of their Enterprise Risk Management (ERM) strategies, as determined from their
disclosures as required by ASX (measured as RISKMGT). Highest ranked are companies
with formal ERM policies with oversight delegated to a dedicated committee separate from
the board (ranked 2); next ranked are companies with formal ERM policies but no separate
committee oversight (ranked 1); and companies with no formal ERM policies are ranked
lowest (0).

3.4. Exogenous variable

3.4.1. Institutional ownership
The Osiris database classifications are used to identify institutional ownership. The
investor categories include banks, insurance companies, pension funds, other investment
firms,8 and hedge funds. For each category, institutional investment is computed as the
proportion of institutional investors' shares of total shares outstanding.

3.5. Instrumental variables

We use prior-year performance reported return on assets (ROAt 1) Tobin's Q
(TOBQt 1), as it is likely to have an impact on current performance. Inclusion of the lag
of the dependent variable is likely to mitigate concerns over reverse causality and omitted
variables. To the extent that omitted correlated variables are relatively stable, their effects
can be captured by lagged values of the dependent variable. Moreover, using a lagged
dependent variable makes reverse causality less plausible, because if profitability determines the levels of institutional stockholding, why would institutional stockholding continue to explain future profitability even when contemporaneous profitability is controlled
for? Firm size is often included as a control variable in previous corporate governance
studies (e.g., Pathan, 2009), as an increase in firm size is likely to lead to greater monitoring and hence the greater need for corporate control mechanisms. We measure size
as the log of market capitalization (LNMKTCAP), and the log of total assets (LNTA).
NETGEARING and NETINTCOV (net interest coverage) are included for their effect on
risk. We include industry (IND) by a dummy variable of 1 if in the metals and mining
industry, and 0 otherwise, as this industry is the most represented in the sample. Finally,
we include year dummy variables to control for the effects of the GFC on the risk and
performance relation.

Similar to pension funds, these are large listed rms that exist solely to invest in other rms.

40

Table 1
Descriptive statistics for all years and each year.
2006 (N = 220)

2007 (N = 241)

2008 (N = 251)

Mean

Median

Std.dev

Mean

Median

Std.dev

Mean

Median

Std.dev

Mean

Median

Std.dev

ALLINST
SENSITIVE
RESISTANT
BDINDEP
BDSIZE
ROAt
TOBQt
MKTCAP ($A000)
MBVE
STDEV
INDADJSTD
ALTMANZSCORE

54.31%
10.47%
43.84%
52%
6.44
0.07
2.58
4,548,105
4.11
11.07
6.51
14.24

47.72%
6.44%
39.17%
50%
6.00
0.07
1.81
547,150
2.65
9.10
4.80
3.46

40.63%
12.31%
32.82%
24%
2.12
0.14
2.68
17,494,656
5.77
6.40
6.01
62.53

43.75%
6.31%
37.44%
51%
6.38
0.06
2.74
4,190,038
4.32
10.07
5.55
12.00

38.01%
3.12%
34.15%
50%
6.00
0.08
1.87
463,694
2.91
8040
3.90
3.66

31.68%
8.233%
27.35%
24%
2.17
0.14
2.91
15,622,609
8.18
6.11
5.79
3.89

47.05%
10.58%
36.46%
52%
6.46
0.07
2.95
5,242,508
5.03
9.80
5.87
15.86

41.06%
7.14%
32.24%
56%
6.00
0.08
2.06
664,432
3.23
8.00
4.40
3.58

35.23%
12.08%
27.78%
24%
2.14
0.14
2.97
19,282,235
6.51
5.77
5.38
53.60

70.55%
14.01%
56.54%
52%
6.48
0.07
2.22
4,195,210
2.94
13.16
7.96
14.62

66.51%
10.31%
51.19%
50%
6.00
0.07
1.40
489,787
1.95
11.20
6.10
3.09

47.02%
14.21%
37.64%
25%
2.06
0.13
2.54
17,191,798
3.64
6.71
6.50
84.58

Variable-dichotomous

Coding

No. of
firms in
sample

% of
sample

Coding

No. of firms
in sample

% of
sample

Coding

No. of
firms in
sample

% of
sample

Coding

No. of
firms in
sample

% of
sample

RISKMGT

0
1
2
1
1

72
217
423
579
142

10.1%
30.5%
59.4%
81.3%
25.8%

0
1
2
1
1

39
108
169
249
39

12.3%
34.2%
53.5%
78.8%
23.0%

0
1
2
1
1

30
99
187
253
44

9.5%
31.3%
59.2%
80.1%
22.5%

0
1
2
1
1

39
108
169
260
59

12.3%
34.2%
53.5%
82.3%
31.6%

AUDITOR
ZSCORE

Definitions:
ALLINST: all institutional ownership divided by total issued shares; SENSITIVE: bank and insurance company ownership divided by total issued shares; RESISTANT:
pension funds, investment firms, and hedge fund ownership divided by total issued shares; BDINDEP: number of independent directors divided by board size; BDSIZE:
number of directors on the board; ROAt: current year ROA [Net Income + Interest Expense (1 Corporate Tax Rate)] / [Total Assets Outside Equity Interests];
TOBQt: the market value of equity and debt divided by the book value of total assets in year t; MBVE: closing share price on the last day of the company's financial year /
shareholders' equity per share; STDEV: total risk is calculated as the standard deviation of firm daily stock returns for each fiscal year; INDADJSTD: total risk is calculated
as the standard deviation of firm daily stock returns for each fiscal year, which is subtracted from the industry standard deviation of daily stock returns;
ALTMANZSCORE = Altman Z score for financial distress; RISKMGT: dummy variables 2 = rigorous RM policies with oversight of a dedicated (separate) committee,
1 = formal RM policies but no separate committee oversight (oversight by board), 0 = no formal RM policies (or dedicated committee oversight); AUDITOR: dummy
variable 1 if audited by top-tier auditor, 0 otherwise; ZSCORE: dummy variable 1 if ZScore b 1.81, 0 if N2.99.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

All years (N = 712)

Variable-continuous

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

41

4. Results
Table 1 reports the descriptive statistics for the variables related to institutional
investment, firm governance, and financial performance characteristics for the three years.
The results show that there is very little change in the governance variables over time, and
this is to be expected (see Brown, Beekes, & Verhoeven, 2011). However, there is
considerable growth in institutional ownership from 2006, with a mean of 44% of issued
shares, to 2008, where institutional investment is 71% of issued shares on average. We also
identify that the period under investigation is one of increasing total risk. Total risk
(STDEV) is 10.07 in 2006, growing to 13.16 in 2008. Industry adjusted risk is 5.55 in 2006
and 7.96 in 2008.
The results of correlating the transformed variables are reported in Table 2. There are
significant correlations between risk-management, risk, performance, and institutional
ownership, providing some support for the hypotheses. Variance inflation statistics were
run to test the issue of multicollinearity. The VIFs were all below 3, indicating that
multicollinearity is not an issue with the data.
4.1. GLS regression results
Table 3 provides the results of the 3SLS regression model. Column 1 of Table 3 Panel A
shows the effect of institutional ownership on firm-specific risk, as specified by Eq. (1).
Column 2 shows the effect of risk and institutional ownership on risk-management (Eq. (2)).
Column 3 shows the effect of firm-specific risk, risk-management, and institutional
ownership on ROA (Eq. (3)). Panel B shows the same associations using Tobin's Q as the
measure of firm performance.
In Panel A and B of Table 3 we find that firm-specific risk (INADJSTD) is positively
associated with institutional ownership (B = 0.072; p b 0.001), thus supporting H1,
indicating that institutional investors desire more risk-taking. While testing H2, we find
risk-management policy is negatively associated with firm-specific risk (B = 0.059;
p b 0.001) and positively associated institutional ownership (B = 0.004; p b 0.001),
suggesting that institutional investors increase their ownership in firms with a more
comprehensive risk-management policy, because these firms bear the cost of monitoring
suboptimal risk-taking.
Column 3 shows the results from testing H3. Firm accounting performance (ROA) is
positively associated with institutional ownership (B = 0.001; p b 0.001). Thus, even
while directly and simultaneously controlling for endogeneity with 3SLS, the study shows
that increasing the size of institutional ownership is associated with increasing accounting
performance. We interpret this result as suggesting that large investors have sufficient
ownership (skin in the game) to encourage investee firms to monitor and increase
short-term returns.
Next, we determine whether the increase in short term accounting performance is made
to the detriment of long-term firm value (Tobin's Q), which includes the markets'
subjective assessment of future performance. Table 3 Panel B shows the same association
as Panel A when using Tobin's Q as the measure of performance. Tobin's Q is positively
associated with the size of institutional ownership (B = 0.025; p b 0.01). This result is

42

ROAt
TOBQt
INDADJSTD
ALLINST
RISKMGT
NETINTCOV
NETGEAR
LNMKTCAP
INDY
2006
2007
2008

ROAt

TOBQt

INDADJSTD

ALLINST

RISKMGT

NETINTCOV

NETGEAR

LNMKTCAP

INDY

2006

2007

2008

1
0.052
0.406***
0.177***
0.223***
0.001
0.003
0.194***
0.230***
0.031
0.009
0.021

1
0.323***
0.108**
0.113**
0.003
0.208***
0.025
0.161**
0.001
0.094**
0.094***

1
0.141***
0.287***
0.004
0.145***
0.321***
0.428***
0.102**
0.080*
0.178***

1
0.337***
0.023
0.124***
0.290***
0.005
0.175***
0.128***
0.296***

1
0.004
0.19.***7
0.312***
0.174***
0.111**
0.004
0.111**

1
0.070*
0.004
0.020
0.051
0.010
0.039

1
0.184***
0.073*
0.003
0.005
0.002

1
0.015
0.091**
0.109***
0.019

1
0.227***
0.119***
0.102***

1
0.476***
0.495***

1
0.529***

Definitions:
ROAt: current year ROA [Net Income + Interest Expense (1 Corporate Tax Rate)] / [Total Assets Outside Equity Interests; TOBQt: the market value of equity and
debt divided by the book value of total assets in year t; INDADJSTD: total risk is calculated as the standard deviation of firm daily stock returns for each fiscal year, which
is subtracted from the industry standard deviation of daily stock returns; ALLINST: institutional ownership as a percentage of total issued shares; RISKMGT: dummy
variables 2 = rigorous RM policies with oversight of a dedicated (separate) committee, 1 = formal RM policies but no separate committee oversight (oversight by board),
0 = no formal RM policies (or dedicated committee oversight); LNMKTCAP: closing share price on the last day of the company's financial year number of shares
outstanding at the end of the period, logged; NETGEARING: (Short term debt + long term debt cash) / shareholders' equity; NETINTCOV: earnings before interest and
tax / net interest (income expense); INDY: dummy variable 1 for metals and mining industry, 0 otherwise; YEAR: dummy variable 1 for 2006, 2007, and 2008; 0
otherwise.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

Table 2
Pair-wise correlations of variables. This table provides the correlation coefficients of variables. The tests are significant at 0.01***; 0.05**; 0.10* levels (N = 676).

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

43

Table 3
Determinants of firm performance (ROA and Tobin's Q). This table presents the instrumental variables in the form
of 3SLS regression models. The first-stage model is not reported for parsimony. The results of simultaneously
testing the three equations for the role of institutional investors on risk, risk management, and performance are
presented. Two-tailed Z statistics in parentheses significant at 0.01***; 0.05**; 0.10* levels.
Panel A: ROAt

CONS

INADJSTD

RISKMGT

ROAt

INADJSTD

RISKMGT

TOBQt

27.160
(21.32)***

1.584
(13.47)***
0.059
( 20.85)***

0.212
( 2.04)**
0.003
(0.72)
0.147
( 2.37)***
0.001
(3.08)***

25.921
(17.65)***

1.156
(8.48)***
0.061
( 15.67)***

30.129
(7.61)***
1.029
(5.39)***
3.311
( 1.19)
0.025
(2.12)**

INDADJSTD
RISKMGT
ALLINST
NETGEARING
NETINTCOV

16.478
( 17.46)***
0.072
0.004
(6.73)***
(7.58)***
0.044
(0.40)
0.00004
( 0.14)

LNMKTCAP

15.395
( 13.43)***
0.064
0.004
(6.08)***
(7.27)***
0.087
(0.58)
0.0001
( 0.58)

0.021
(3.33)***

LNTA

0.003
(0.52)

ROAt 1 / TOBQt 1
INDY
2007
2008
N
CH12
p

Panel B: TOBQt

688
382.37
0.00

688
559.36
0.00

1.493
(6.96)***
0.007
(0.85)

0.573
(13.07)***
0.119
( 4.39)***
0.005
(0.43)
0.013
( 0.71)
688
675
513.49
222.08
0.00
0.00

675
406.06
0.00

0.092
(0.78)
6.912
( 5.97)***
0.955
(2.21)**
1.764
( 2.41)***
675
195.62
0.00

Definitions:
INDADJSTD: total risk is calculated as the standard deviation of firm daily stock returns for each fiscal year,
which is subtracted from the industry standard deviation of daily stock returns; ROAt: current year ROA [Net
Income + Interest Expense (1 Corporate Tax Rate)] / [Total Assets Outside Equity Interests; ROAt 1:
prior year ROA; TOBQt: the market value of equity and debt divided by the book value of total assets in year t;
TOBQt 1: prior year TOBQ; RISKMGT: dummy variables 2 = rigorous RM policies with oversight of a
dedicated (separate) committee, 1 = formal RM policies but no separate committee oversight (oversight by
board), 0 = no formal RM policies (or dedicated committee oversight); ALLINST: institutional ownership as a
percentage of total issued shares; LNMKTCAP: closing share price on the last day of the company's financial
year number of shares outstanding at the end of the period, logged; NETGEARING: (Short term debt + long
term debt cash) / shareholders' equity; NETINTCOV: earnings before interest and tax / net interest (income
expense); LNTAt = Total assets, logged; INDY: dummy variable 1 for metals and mining industry, 0 otherwise;
YEAR: dummy variable 1 for 2006, 2007, and 2008; 0 otherwise.

contrary to Velury, Reisch, and O'Reilly's (2003) prediction that institutional investors
prefer short term profit (accounting profit) over long-term future returns (Tobin's Q).
Consequently, this paper provides some preliminary findings that show that institutional

44

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

Table 4
Determinants of firm performance (ROA and Tobin's Q). This table presents the second-stage results of the
Heckman's (1979) two-step procedure of the determinants of institutional ownership, which is a probit model that
determines when the dependent variable (institutional ownership) in the second stage is not missing for
performance. The first-stage is not reported for parsimony. This table presents the second-stage of testing the
determinants of firm performance using random effects GLS with cluster robust standard errors. MILLS is the
correction term computed from the probit model in the first stage. A three-way interaction term for: risk,
risk-management, and institutional ownership test the three equations. Two-tailed Z statistics in parentheses
significant at 0.01***, 0.05**, and 0.10* levels.

CONS
ROAt-1/TOBQt-1
INDADJSTD
ALLINST
RISKMGT
INDADJ RISKMGT ALLINST
LNMKTCAP
INDY
MILLS
2007
2008
N
Firms
Wald
Rsq

ROAt

TOBQt

Coef.

Coef.

0.023
(0.42)
0.450
(6.01)***
0.003
( 2.19)**
0.00003
(0.20)
0.003
( 0.46)
0.00002
(2.18)**
0.003
(0.76)
0.040
(2.59)***
0.025
(1.36)
0.003
( 0.36)
0.009
( 1.16)
710
255
352.18***
0.775

1.62
( 1.31)
0.372
(3.59)***
0.154
(3.87)***
0.008
(2.14)**
0.082
(0.47)
0.001
( 3.22)***
0.115
(1.90)*
0.109
(0.31)
0.628
(1.36)
0.089
(0.57)
0.755
( 4.72)***
697
250
100.16***
0.638

Definitions:
ROAt: current year ROA [Net Income + Interest Expense (1 Corporate Tax Rate)] / [Total Assets Outside
Equity Interests]; ROAt 1: prior year ROA; TOBQt: the market value of equity and debt divided by the book value of
total assets in year t; TOBQt 1: prior year TOBQ; INDADJSTD: total risk is calculated as the standard deviation of
firm daily stock returns for each fiscal year, which is subtracted from the industry standard deviation of daily stock
returns; ALLINST: institutional ownership as a percentage of total issued shares; RISKMGT: dummy variables 2 =
rigorous RM policies with oversight of a dedicated (separate) committee, 1 = formal RM policies but no separate
committee oversight (oversight by board), 0 = no formal RM policies (or dedicated committee oversight);
INDADJ RISKMGT ALLINST: interaction of risk, risk-management, and institutional ownership; LNMKTCAP:
closing share price on the last day of the company's financial year number of shares outstanding at the end of the
period, logged; INDY: dummy variable 1 for metals and mining industry, 0 otherwise; MILLS: Inverse Mills Ratio
computed from the first stage regression; YEAR: dummy variable 1 for 2006, 2007, and 2008; 0 otherwise.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

45

shareholder activism is associated with increasing short-term accounting performance and

has some influence in creating long-term firm value.
4.2. Robustness tests
To test the validity of our results, we use random effects generalized least square (GLS)
regression, estimated with firm clustered-robust (also referred to as HuberWhite) standard
errors on firm to control for any serial dependence in the data (Gow, Ormazabal, & Taylor,
2010; Petersen, 2009). While testing the hypotheses, we control for the potential problem
of selection bias with the two-stage Heckman (1976) procedure, because our sample may
be biased-based. We first compute the Inverse Mills Ratio (MILLS) (Heckman, 1976;
Johnston & DiNardo, 1997) from the model that predicts the factors that are associated
with institutional ownership. The dependent variable is INSTDUM, which is a dummy
variable equal to 1 if the firm has a high institutional ownership concentration (greater than
the median 52.4) and 0 otherwise.
In the second stage we include the MILLS as a correction factor for potential selection
bias. We include a three-way interaction term in stage two and report the results in Table 4.
After controlling for potential selection bias by testing factors that are likely to be associated
with institutional ownership in stage one, the results show that ROA is positively associated
with the size of institutional investors' investment, firm-specific risk, and comprehensive
risk-management (B = 0.00002; p b 0.01). In contrast, Tobin's Q is negatively associated
with the interaction term (B = 0.001; p b 0.001).
The random effects regression is likely to produce either non-significant coefficients or
coefficients that are statistically significant but of substantially lower magnitude, compared
to 3SLS regression. This is because the random effects regressions will possibly produce
biased standard errors and suffer from Type I errors. In contrast, the 3SLS method, which
takes into account covariances between the error terms of different equations, is more
likely to provide unbiased and consistent standard errors, thus yielding more robust
coefficient results and valid tests of hypotheses (Setia-Atmaja, Tanewski, & Skully,
2009).9
4.3. Institutional investor heterogeneity
One issue that arises in measuring institutional influence is that not all institutions are
willing or able to exert influence. A growing body of corporate governance literature refers
to this as institutional investor heterogeneity (Agrawal, 2012). Using economic theories
relating to incentives, we distinguish broadly between pressure-resistant investors, who have
more economic incentive to monitor, and pressure-sensitive investors, who have less
economic incentive to monitor, based on conjecture that they have competing economic
incentives due to their potential business relationships with investee firms. The constructs of
9
The DurbinWuHausman (DWH) test, which determines whether there is no endogeneity in the equation
(null hypotheses). The signicant DWH tests (F(1, 681); p = 0.0000) indicate that endogeneity is present in the
OLS estimates and the instruments have corrected for it.

46

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

activism (i.e., pressure-sensitive versus pressure-resistant) therefore are primarily driven

by theory, not by actual observed evidence of monitoring behavior of the sampled firms.
This compelling distinction relies on recognizing significant business relationships that
investors have with their firms, based on the industry of the investor and the ordinary
course of their business. While studies on institutional investors consider various methods
of distinguishing institutional investor incentives to monitor for example, political or
social influences conflicting with the objective of firm performance (Agrawal, 2012; Gillan
& Starks, 2000; Woidtke, 2002) we follow Brickley, Lease, and Smith (1988) and
Almazan, Hartzell, and Starks (2005), who divide institutional investors into two groups,
pressure-sensitive and pressure-insensitive investors.10
Institutional investors are categorized into two groups based on their potential business
relations with the firms in which they invest. The first group is defined as pressuresensitive owners as, due to the potential business relations with investee firms, they may be
less likely to challenge management for fear of jeopardizing the relation. Osiris classifications
are used with pressure-sensitive institutions, including banks and insurance companies. The
second group is defined as pressure-resistant owners, due to the expectation that they will
not have significant potential business relations with firms and are therefore more likely to
directly challenge management. These institutions include pension funds, other investment
firms,11 and hedge funds. For each category, institutional investment is computed as the
proportion of institutional investors' shares of total shares outstanding. The proportion of
banks and insurance companies' ownership is added together (SENSITIVE), and the proportion of pension funds, other investment firms, and hedge fund ownership is added together
(RESISTANT).
The results reported in Table 5 show that firm accounting performance (ROA) and firm
value (Tobin's Q) are positively associated with pressure-resistant institutional ownership
(B = 0.001; p b 0.001; B = 0.033; p b 0.001). Performance and value are not significantly
associated with pressure-sensitive institutional ownership. This result suggests that it is
only institutional investors without a possible business association with the investee firm
that persuade the firm to monitor suboptimal risk-taking, indicated by a positive
association between the size of pressure-resistant institutional ownership and performance.
An alternative explanation is that pension funds (the major investor in this group) are more
likely to invest for the long-term, which also leads to greater monitoring of performance by
these funds. In contrast, pressure-sensitive institutional investors are less likely to directly
pressure firms and, in fear of losing their business, rely on firms' internal governance practices.
Typically, insurance companies, the primary investor in this group, are likely to be replaced
if they challenge management.12
Next, we use an alternate measure of firm-specific risk: the probability of bankruptcy.
The most popular and robust measure of bankruptcy risk is the Altman Z score model,
which uses discriminate analysis (DA) to combine five accounting ratios into a score that
represents the bankruptcy risk inherent in a firm (Altman, 1968). Although the model was
introduced in the late 1960s, it is still relevant and used for financial research to proxy for
10
11
12

We prefer the term pressure-resistant.

Similar to pension funds, these are large listed rms that exist solely to invest in other rms.
Running the analysis with pension funds and insurance funds provided the same results.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

47

Table 5
Determinants of firm performance (ROA and Tobin's Q). This table presents the instrumental variables in the form
of 3SLS regression models. The first-stage model is not reported for parsimony. The results of simultaneously
testing the three equations for the role of institutional investor type (pressure sensitive and pressure resistant) on
risk, risk management, and performance are presented. Two-tailed Z statistics in parentheses significant at
0.01***, 0.05**, and 0.10* levels.
Panel A: ROAt

CONS

RISKMGT

ROAt

INADJSTD

RISKMGT

TOBQt

27.609
(21.58)***

1.593
(14.13)***
0.059
( 21.22)***

0.217
( 2.06)**
0.003
(0.75)
0.145
( 2.31)**
0.0007
(1.18)
0.001
(3.51)***

26.440
(17.87)***

1.537
(8.93)***
0.060
( 16.02)***

30.483
(7.61)***
1.033
(5.44)***
3.110
( 1.11)
0.009
( 0.32)
0.033
(3.02)***

INDADJSTD
RISKMGT
SENSITIVE
RESISTENT
NETGEARING
NETINTCOV

Panel B: TOBQt

INADJSTD

16.739
( 17.84)***
0.156
(4.16)***
0.050
(3.48)***
0.040
(0.38)
0.00004
( 0.13)

0.009
(4.25)***
0.003
(3.62)***

LNMKTCAP

0.009
(4.27)
0.003
(3.46)***

1.491
(7.00)***

0.021
(3.33)***

LNTA

0.002
(0.48)

ROAt 1 / TOBQt-1
INDY
2007
2008
N
CH12
p

15.717
( 13.71)***
0.148
(4.16)***
0.043
(3.15)***
0.083
(0.58)
0.0002
( 0.69)

688
401.48
0.00

688
576.79
0.00

0.006
(0.77)
0.573
(13.10)***
0.119
( 4.40)***
0.007
(0.57)
0.013
( 0.70)
688
516.61
0.00

675
232.35
0.00

675
419.42
0.00

0.092
(0.78)
6.918
( 6.02)***
1.088
(2.64)***
1.736
( 2.44)**
675
198.74
0.00

Definitions:
INDADJSTD: total risk is calculated as the standard deviation of firm daily stock returns for each fiscal year,
which is subtracted from the industry standard deviation of daily stock returns; ROAt: current year ROA [Net
Income + Interest Expense (1 Corporate Tax Rate)] / [Total Assets Outside Equity Interests; ROAt 1:
prior year ROA; TOBQt: the market value of equity and debt divided by the book value of total assets in year t;
TOBQt 1: prior year TOBQ; RISKMGT: dummy variables 2 = rigorous RM policies with oversight of a
dedicated (separate) committee, 1 = formal RM policies but no separate committee oversight (oversight by
board), 0 = no formal RM policies (or dedicated committee oversight); SENSITIVE: bank and insurance
company ownership divided by total issued shares; RESISTANT: pension funds, investment firms, and hedge
fund ownership divided by total issued shares; LNMKTCAP: closing share price on the last day of the company's
financial year number of shares outstanding at the end of the period, logged; NETGEARING: (Short term
debt + long term debt cash) / shareholders' equity; NETINTCOV: earnings before interest and tax / net
interest (income expense); LNTAt = Total assets, logged; INDY: dummy variable 1 for metals and mining
industry, 0 otherwise; YEAR: dummy variable 1 for 2006, 2007, and 2008; 0 otherwise.

48

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

financial distress and default risk (Aslan & Kumar, 2012; Becker & Stromberg, 2012;
Bryan et al., 2013).
Altman (1968) derived a cut-off point, or optimum Z value, by observing firms that
were misclassified by the DA model in the initial sample. He concluded that all firms with
a Z score of greater than 2.99 clearly fall into the non-bankrupt sector, while those firms
with a Z below 1.81 are bankrupt.13 Consequently, firms are classified as firms with a Z of
1.81 as a high probability of bankruptcy and coded 1, and firms with a Z of 2.99 as a
low probability of bankruptcy and coded 0, thus excluding the gray area due to the
propensity of misclassification. Altman (1968) suggests that the predictive model is useful
for screening out undesirable investments, as investors tend to underestimate the extent of
financial difficulties of the firms that eventually go bankrupt.
The results reported in Table 6 Panel A, where firm performance is measured as ROA,
are consistent with the results using firm-specific risk. That is, only pressure-resistant
institutional investors monitor the short-term performance of potentially financiallydistressed firms as short-term performance increases with pressure-resistant institutional
ownership. However, when using Tobin's Q, which measures firm value, while taking into
consideration future cash flows, we find that Tobin's Q is negatively associated with the
size of both types of institutional ownership. This result suggests that all types of institutional
investors exit rather than monitor or pressure financially-distressed firms to increase
long-term value.
This result is consistent with Frino, Jones, Lepone, and Wong (2014), who find that
following the announcement of financial distress, some institutional investors exit the
stock. However, the withdrawal is gradual and is driven by active institutional investors
reacting to the release of the financially-distressed firm's last publicly released financial
report. Their sample of Australian firms (19952006) is before the GFC, while our sample
is in the period leading up to and including the GFC. Interestingly, we find a particularly
strong positive relationship between a comprehensive risk-management policy and Tobin's
Q for distressed firms. This result suggests that in times of distress, stringent riskmanagement is needed to take into account long-term value creation.

5. Conclusion
The global financial crisis has focused attention on the consequences of short-term
investment strategies and urges a reassessment of the balance between risk-taking and
risk-management (Harper Ho, 2010). Kashyap, Rajan, and Stein (2008) suggest that the
global financial crisis resulted from excessive risk-taking, highlighting the importance of
monitoring risk. In the period leading up to the global financial crisis, investors sanctioned
high levels of risk in the pursuit of high returns. Consequently, it is important to determine
whether institutional investors differ in their ability to influence managements' pursuit of
short-term returns or firm value.
13
In Altman's revised model (2000), analyzing rms up to 1999, he nds that the gray area is wider as the lower
boundary is 1.23. However, he suggests that the revised model is weaker than the original. Consequently, the
original model is used in this study.

M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

49

Table 6
Determinants of firm performance (ROA and Tobin's Q). This table presents the instrumental variables in the form
of 3SLS regression models. The first-stage model is not reported for parsimony. The results of simultaneously
testing the three equations for the role of institutional investor type (pressure sensitive and pressure resistant) on
the probability of bankruptcy risk (ZSCORE: Dummy variable 1 if ZScore b 1.81, 0 if N2.99), risk management,
and performance are presented. Two-tailed Z statistics in parentheses significant at 0.01 ***; 0.05**; 0.10* levels.
Panel A: ROAt

CONS

RISKMGT

ROAt

ZSCORE

RISKMGT

TOBQt

0.119
(1.34)

1.027
( 3.13)***
0.301
( 2.14)**

0.170
( 1.22)
0.033
( 0.69)
0.130
( 1.00)
0.001
(1.27)
0.001
(2.21)**

0.031
(0.32)

0.666
(2.08)**
0.040
( 0.28)

107.47
(7.19)***
47.627
( 12.98)***
87.75
(10.51)***
0.410
( 5.80)***
0.133
( 5.29)***

ZSCORE
RISKMGT
SENSITIVE
RESISTANT
NETGEARING
NETINTCOV

0.010
(0.14)
0.003
(1.69)*
0.001
(1.85)*
0.095
(6.94)***
0.0002
(1.18)

0.008
(2.81)***
0.003
(2.49)***

LNMKTCAP

0.080
(1.07)
0.02
(1.29)
0.001
(1.46)***
0.088
(6.45)***
0.0002
(1.50)

0.007
(2.63)***
0.002
(2.22)**

10.199
( 8.60)***

0.019
(1.37)

LNTA

0.120
(6.78)***

ROAt-1/TOBQt-1
INDY
2007
2008
N
CH12
p

Panel B: TOBQt

ZSCORE

550
81.74
0.00

550
100.22
0.00

0.099
(5.75)***
0.516
(7.55)***
0.089
( 1.91)*
0.004
(0.21)
0.002
( 0.08)
550
431.63
0.00

540
80.52
0.00

540
91.26
0.00

0.205
( 1.80)*
26.737
( 8.00)***
9.956
( 7.40)***
12.631
( 8.09)***
540
398.96
0.00

Definitions:
ZSCORE: dummy variable 1 if ZScore b 1.81, 0 if N2.99; ROAt: current year ROA [Net Income + Interest
Expense (1 Corporate Tax Rate)] / [Total Assets Outside Equity Interests; ROAt 1: prior year ROA;
TOBQt: the market value of equity and debt divided by the book value of total assets in year t; TOBQt 1: prior
year TOBQ; RISKMGT: dummy variables 2 = rigorous RM policies with oversight of a dedicated (separate)
committee, 1 = formal RM policies but no separate committee oversight (oversight by board), 0 = no formal RM
policies (or dedicated committee oversight); SENSITIVE: bank and insurance company ownership divided by
total issued shares; RESISTANT: pension funds, investment firms, and hedge fund ownership divided by total
issued shares; LNMKTCAP: closing share price on the last day of the company's financial year number of
shares outstanding at the end of the period, logged; NETGEARING: (Short term debt + long term debt cash) /
shareholders' equity; NETINTCOV: earnings before interest and tax / net interest (income expense);
LNTAt = Total assets, logged; INDY: dummy variable 1 for metals and mining industry, 0 otherwise; YEAR:
dummy variable 1 for 2006, 2007, and 2008; 0 otherwise.

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M. Hutchinson et al. / The International Journal of Accounting 50 (2015) 3152

Institutional investors are an important component of capital markets, especially in times of

increasing risk and risk-monitoring. However, there are significant differences among
institutional investors and the institutional context in which they exist. First, using
instrumental variables to control for potential endogeneity, this study shows that
firm-specific risk and a firm's comprehensive risk-management policy are associated
with the size of institutional ownership. We find that institutional ownership increases with
a comprehensive measure of risk-management, regardless of the type of institutional
investor. Our results demonstrate that increasing institutional ownership is associated with
increasing accounting performance and firm value. That is, large institutional investors
have sufficient skin in the game to pressure firms to monitor risk and increase both shortand long-term performance.
However, institutional investors are not a homogeneous group. They have an overriding
responsibility to their clients, but they have different investment objectives (Webb et al.,
2003). We categorize institutional investors based on their ability to influence management. The ability to influence management depends on the size of the investment and
whether the investee firm has or could have business dealings with the investor, classified
as pressure sensitive, vis-a-vis pressure-resistant institutional investors, where there is
no such potential. Our results highlight that the ability of market forces (institutional
investors) to influence short-term accounting performance and long-term value depends on
increasing pressure-resistant institutional ownership.
The results also demonstrate the importance of risk-management policy for financiallydistressed firms. We find that when firms are financially distressed, institutional investors
engage in promoting short-term performance or exit rather than support long-term value
creation. The study of institutional investors and the incentive to have skin in the game
can provide important insights into widespread perceptions that institutional investors have
superior information, which in turn leads to engagement or exit of portfolio firms. These
findings add to the growing body of literature examining institutional ownership and the
importance of understanding the role of risk-management in the risk and return relation.
This information can enable diversified investors to structure their portfolios in accordance
with their risk preference.
Acknowledgments
The authors are grateful for comments received from Tom Smith, Robert Faff,
Francesco Bova, and from the participants at the Accounting and Finance Association of
Australia and New Zealand Conference, Melbourne Australia, July 2012, and the
International Journal of Accounting Symposium, Zhongnan University of Economics and
Law, China, May 2013.
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